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ECB Cash Averts ‘Funding Crisis’

Italy, Spain and Belgium have seen borrowing costs ease.

The European Central Bank’s unprecedented cash injection is easing borrowing costs for Italy, Spain and Belgium, compensating for the lack of a solution to the debt crisis and the risk of recession.

Two-year Italian yields have dropped by 50 basis points and Belgian notes of the same maturity have declined by 22 basis points since Dec. 21, when the ECB supplied banks with 489 billion euros ($636 billion) of three-year loans. Short-dated Italian and Spanish debt outperformed AAA rated German and Dutch securities during that period.

“Short-term borrowing costs have come down significantly and that certainly helps to buy time,” said Jens Nordvig, managing director of currency research at Nomura Holdings Inc. in New York. “Six weeks ago, it looked as if there was going to be an imminent funding crisis, but that’s averted by the ECB’s money injection.”

The ECB, led by President Mario Draghi, cut its key interest rate last month for the second time in a quarter and offered unlimited three-year cash at 1 percent to persuade banks, saddled with deteriorating assets including bonds from so-called peripheral Europe, to keep providing credit to the region. Some of that money is probably being invested in sovereign debt, said Fabrizio Fiorini, who helps oversee $8 billion as chief investment officer at Aletti Gestielle SGR SpA in Milan.

Italian notes maturing within three years handed investors a 0.56 percent gain since Dec. 21, beating a 0.14 percent return from German debt and a 0.2 percent advance for Finnish securities, bond indexes compiled Bank of America Merrill Lynch show. Spanish notes returned 0.78 percent. The Stoxx Europe 600 Index has risen 5.6 percent since the ECB allotted the funds.

“Some of the cash and the liquidity the ECB has provided is likely to be recycled into peripheral debt,” Fiorini said. “This should allow Italy and Spain to raise money at lower borrowing costs, at least in the first quarter.”

Italy sold 9 billion euros of bills on Dec. 28 at about half the rate of the previous sale in November. It auctioned bonds due March 2022 the next day at an average yield of 6.98 percent, down from the 7.56 percent it paid at a Nov. 29 sale.

Belgium, whose credit rating was cut two steps by Moody’s Investors Service on Dec. 16, raised more money than planned at a Jan. 3 debt sale as borrowing costs fell to the lowest level in 18 months. It sold 2.44 billion euros of three- and six-month treasury bills, compared with a target of 2.2 billion euros.

Recession Risk

The European Commission cut its 2012 growth forecast by more than half to 0.5 percent in November, while Luxembourg Prime Minister Jean-Claude Juncker said yesterday that the region is “on the brink of a recession of which one doesn’t yet know its scope.” The euro posted its first back-to-back annual losses against the dollar in a decade last year.

Standard & Poor’s said Dec. 15 that it was reviewing the credit ratings of 15 euro nations for a possible downgrade, including AAA rated Germany and France, citing “systemic stress in the euro zone.”

France sold 7.96 billion euros of bond maturing in 2021, 2023, 2035 and 2041 today, with borrowing costs rising in its first auction of the year. The debt maturing in 2021 was sold at an average yield of 3.29 percent, up from 3.18 percent in the previous auction on Dec. 1.

With European leaders failing to come up with what German Chancellor Angela Merkel described as a “big-bang” solution to the crisis, the ECB has taken unprecedented steps to prevent the crisis from spreading. The 489 billion euros it lent to 523 banks last month exceeded the median estimate of 293 billion euros in a Bloomberg News survey of economists. The central bank will offer a second three-year loan on Feb. 28. A report last month showed its balance sheet swelled to a record 2.73 trillion euros on increased lending.

The central bank has also bought bonds to curb rising yields. Italy’s 10-year borrowing cost topped 7 percent in November, the level that prompted Greece, Portugal and Ireland to seek bailouts, and has been stuck at about 6.9 percent this week.

At 4.57 percent, Italy’s two-year funding cost is below its six-month average of 4.69 percent, and down from more than 7.66 percent on Nov. 25. Spanish two-year yields of 3.48 percent have dropped from more than 6 percent six weeks ago.

“If you look at short-dated Italian or Spanish bonds, there is some evidence that the money from the ECB is being used to buy these bonds,” said Mohit Kumar, head of European fixed-income strategy at Deutsche Bank AG in London. “The ECB’s role is crucial in containing the crisis. It may have constraints it needs to think of, but it’s not without policy tools.”

Bloomberg News

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